Question

Question Set 7: Purchasing Power Parity and the Law of One Price

The table below contains the price of a Big Mac in different countries in the world in January 2017[1]. You will use the information in the table to explain how Big Macs would be traded between countries if Big Macs could be traded among countries.

Country	Big Mac Price	Purchasing Power Parity Exchange Rate	Actual Exchange Rate	Actual Price in U.S. Dollars
United States	$5.10 (U.S.)	1.0 U.S. Dollar per U.S. Dollar	1.0 U.S. Dollar per U.S. Dollar	$5.10
Japan	380 Yen		116.7 Yen per U.S. Dollar
Switzerland	6.5 Swiss Francs		1.0
Indonesia	31,000 Rupiahs		13,329 Rupiahs per U.S. Dollar
Canada	6 Canadian Dollars		1.3 Canadian Dollars per U.S. Dollar
China	19.6 Yuan		6.9 Yuan per U.S. Dollar
Mexico	49 Pesos		22.0 Pesos per U.S. Dollar

With the information in the table above, complete and answer the following:

Calculate the purchasing power parity exchange rate between the United States and each of the countries listed above. Remember, purchasing power parity assumes the price of Big Macs in each country would equal $5.10 U.S. dollars.

Using the actual exchange rate in January 2017, calculate the actual price of the Big Mac in U.S. dollars in each country.

If Big Macs were freely traded among countries, in which country would you purchase Big Macs? To which country would you trade Big Macs? What will happen to the price of Big Macs over time in the world if trade occurred?

Explain whether purchasing power parity holds between countries in the long-run.

What factors explain differences in exchange rates in the long-run?

[1] “The Big Mac Index”, The Economist, January 12, 2017.

Answer 1

COUNTRY	BIG MAC PRICE	PURCHASING POWER PARITY EXCHANGE RATE	ACTUAL EXCHANGE RATE	ACTUAL PRICE IN U.S. DOLLARS
UNITED STATES	$5.1 (U.S.)	1.0 U.S. DOLLAR PER U.S. DOLLAR	1 U.S. DOLLAR PER U.S. DOLLAR	$5.10
JAPAN	380 YEN	595.17 YEN	116.7 YEN PER U.S. DOLLAR	$3.26
SWITZERLAND	6.5 SWISS FRANCS	6.5 SWISS FRANCS	1	$5.10
INDONESIA	31000 RUPIAHS	67467.9 RUPIAHS	13229 RUPIAHS PER U.S. DOLLAR	$2.34
CANADA	6 CANADIAN DOLLARS	6.63 CANADIAN DOLLAR	1.3 CANADIAN DOLLARS PER U.S. DOLLAR	$4.62
CHINA	19.6 YUAN	35.19 YUAN	6.9 YUAN PER U.S. DOLLAR	$2.84
MEXICA	49 PESOS	112.2 PESOS	22.0 PESOS PER U.S. DOLLAR	$2.23
1)	If Big Mac would freely trade then I will purchase from China
2)	I would trade to U.S and Switzerland
3)	I world trade occur then there will be fall in purchasing power of U.S. and Switzerland for Big Mac product